Prospective franchisees interested in investing in a franchise are encouraged to do their due diligence before signing on the dotted line or paying the franchise fee. And one of the best starting points is by reading the specific franchisor’s franchise disclosure document (FDD).
Suppose the concept is new to you and you are wondering what is a franchise disclosure document or what the purpose of this document is. In that case, the answer is that it is a legally mandated document, enforced by the Federal Trade Commission (FTC) in the United States. The FTC requires franchisors to disclose information about every aspect of their business to potential buyers so that they can make an informed purchasing decision.
The FDD consists of 23 items, each focusing on a specific aspect of the franchise business. Below, we cover what is included in a franchise disclosure document, enabling you to read an FDD with confidence. Let’s begin.
What is included in the franchise disclosure document?
If you want to know how to read a franchise disclosure document like an expert, you need to understand what to look out for. The FDD is divided into 23 items, each of which deals with a separate aspect of the franchise business. Below, we explore each of these items, enabling you to understand it better and manage your expectations as you embark on your journey into franchising. Let’s take a look at each item in detail.
Read more: Spotting Red Flags in a Franchise Disclosure Document (FDD)
Franchisor’s background (FDD Item 1)
Here, you’ll find a description of the company and read its history plus how long they’ve been in business for. You can also find information about any parents of the franchisor, including predecessors and affiliates.
Another aspect you’ll find here is information about the franchisor’s competition as well as any special licenses or permits you need to have before getting started. This information equips you with knowledge about the foundations of the franchise business and any potential risks you may encounter.
Business background (FDD Item 2)
In this section, you will learn more about the people who stand behind the franchise. In particular, you will read about their business experience, biographical, and professional information about the franchisor as well as all of its officers, directors, and executives.
It is important to keep an eye out for how long they’ve been involved in franchising and what type of successes they have experienced along the way to ensure that the team behind the franchise is competent enough to run the business.
Litigation history (FDD Item 3)
The litigation history item of the FDD focuses on any and all past and present criminal and civil litigation that the franchisor and any member of its management team has been involved in.
It can also include details about whether the franchisor has been sued by a franchisee or whether the franchisor themselves have sued a franchisee. This information is important because it can demonstrate the levels of franchisee satisfaction and showcase any illicit dealings the franchisor may have been or is involved in.
Bankruptcy (FDD Item 4)
If the franchisor or any of the franchise’s management team, executives, partners, affiliates, or others have been declared bankrupt in the past, the information about this will appear here.
It is important to know this information because it can be telling about the type of support you can expect from the franchisor and how healthy their financial standing is.
Initial fees (FDD Item 5)
Every new franchisee will want to know the costs involved in purchasing a franchise opportunity.
This section offers information about the initial fees payable to the franchisor upon signing the franchise agreement. It will also feature information about the factors that are considered when determining the amount of fees in question.
Other fees (FDD Item 6)
Every franchise has recurring fees or payments (also called royalty payments) that must be paid to the franchisor on an ongoing basis.
In this section, you should be able to see a list of these fees, the amount or percentage involved, and their description.
Initial investment (FDD Item 7)
In addition to the initial fee payable and royalty payments, franchisees must be aware of the total initial investment involved in purchasing the franchise opportunity.
That is why franchisors disclose this information in a table format, which includes every expenditure item that a franchisee will be responsible for when establishing their franchise.
Restriction on sources of products and services (FDD Item 8)
Many franchisors work with suppliers and partners in offering their products or services. In this section, franchisors must disclose any such relationships as well as any potential restrictions related to them.
Franchisee’s obligations (FDD Item 9)
A franchisee typically signs a franchise agreement that initiates the process of starting franchising. They have important obligations and responsibilities to fulfill as a franchisee and that’s why item 9 of the FDD will point the franchisee to the relevant sections of the franchise agreement to have a better understanding of what they are responsible for during the term of the franchise agreement.
Financing (FDD Item 10)
Some franchisors provide franchisees with assistance in securing financing. Any terms and conditions related to financing arrangements that the franchisor offers will be set out in detail in this section.
Franchisor’s assistance, advertising, computer systems, and training (FDD Item 11)
Franchisees often get involved in franchising because they do not wish to be in business on their own. Franchisors offer a range of support services to their franchisees, including advertising and marketing, computer systems, training, and more.
Each of these items should be spelled out in this section to enable the franchisee to have clear expectations of what services they can expect from the franchisor.
Territory (FDD Item 12)
Many franchisors sell their franchise opportunities with a prepackaged geographical territory within which franchisees are permitted to operate. If there are such territorial restrictions, these are set out in item 12 of the FDD.
Trademarks (FDD Item 13)
Any and all of the franchisor’s trademarks, service marks, and trade names are indicated in this section.
Patents, copyrights, and proprietary information (FDD Item 14)
Because franchisors have proprietary rights and information as part of their intellectual property assets, franchisees must know how they are allowed to use them. In item 14 of the FDD, each of these requirements is set out for greater clarity and understanding.
Obligation to participate in the actual operation of the franchise business (FDD Item 15)
In this section, the franchisee will gain a better understanding of their role in running the franchise business. Here, they will learn whether they can operate the business at arm’s length or whether direct participation is required.
Restrictions on what the franchisee may sell (FDD Item 16)
A franchise is often a customer-facing business, selling either products or services. This section lists any restrictions on such products or services that may be offered to customers, setting out specifics relevant to the franchise business in question.
Renewal, termination, transfer, and dispute resolution (FDD Item 17)
The terms and conditions for renewal of the franchise agreement are set out in this section. It also contains information about the termination of the franchise agreement, either before or after the franchise agreement’s term comes to an end.
Other information that is included here includes the potential transfer of ownership and dispute resolution methods and avenues available to both franchise owners and franchisees, in the event that nay arise.
Public figures (FDD Item 18)
Some franchisors rely on public figures (such as celebrities) to endorse or market their products. Such relationships with these figures must be disclosed, in addition to any amounts paid to that person.
Financial performance representations (FDD Item 19)
Financial performance is a critical turning point for many aspiring franchisees. In this section, a franchisor may provide details about certain units’ financial performance. However, prospective franchisees should be aware that this is not a legally mandated requirement.
Outlets and franchisee information (FDD Item 20)
As part of a franchisee’s due diligence process, they often seek to speak to existing franchisees within the network to ask them questions and gain more clarity and insights into how they feel about running the business and what challenges they may be facing.
For this purpose, a franchisor indicates the location and contact information of existing franchisees in this section of the FDD.
Financial statements (FDD Item 21)
Perhaps one of the most crucial aspects of the FDD is the franchise’s financial performance. This is why a special section is dedicated to providing prospective franchisees with this information.
Here, these individuals will be able to see audited financial statements for the past three years (if available) and are encouraged to carefully study the franchisor’s financial performance with the assistance of an accountant.
Contracts (FDD Item 22)
A list of all the agreements that the franchisee will be required to sign will appear in this section for greater transparency into what the expectations are.
Receipt (FDD Item 23)
The final section of an FDD is called the receipt item. This is where prospective franchisees interested in the franchise opportunity sign a receipt that they have received the FDD.
Conclusion
The franchise disclosure document is an essential staple in any prospective franchisee’s decision-making process. It contains valuable information regarding the franchise operations, their future obligations, and the financial performance of the franchisor.
This gives a comprehensive overview of the franchise system’s operations as well as the franchisee’s rights and obligations. Armed with this knowledge, prospective franchisees can make better and more informed decisions as they embark on their journey into the world of franchising.
